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IR35

IR35 is the name commonly used to describe the tax rules relating to intermediaries. It was introduced in April 2000 to counter what was perceived by the Government to be widespread avoidance of employment taxes by people working though an intermediary such as a limited company or partnership. Originally trailed as a means of cracking down on Friday to Monday cases where employers were sacking whole departments and getting the staff to come back as independent consultants, it soon became apparent that IR35 would have a much wider application and affect anyone who offers their services to one client at a time through an intermediary.

IR35 applies when there would have been an employment relationship between the worker and the end-client but for the existence of the intermediary and PAYE has not been applied to the whole of the income derived from that client. In order to decide whether or not there would have been an employment relationship it is necessary under the legislation to construct a hypothetical contract. This will depend on all of the circumstances relating to that particular case, including the terms and conditions of relevant contracts and the actual substance of the arrangements between the parties, including agencies. If it is decided that IR35 applies, a Deemed Payment must be calculated for each tax year in which income is received under that contract and PAYE calculated in accordance with the normal rules.

At Acumen, we will give you a free contract review as part of our annual service for anyone who may be affected by IR35 and advise you how to draft a contract that will minimise the risk. We also calculate potential PAYE liabilities and send you quarterly management accounts, including an update of your IR35 provision, so that you are aware at all times of your possible exposure. As far as we know, this is a unique service not offered by any other firm of accountants. This is in addition to all the usual services such as statutory accounts, corporation tax, VAT returns, PAYE returns, regulatory returns, dividend administration and ongoing support by e-mail and telephone. We offer this unbeatable package for an introductory fixed annual fee of £1,260 plus VAT.

Please see the following information sheets for further details:

Information Sheets Tax Tips
bulletpoint Are you caught by IR35?
bulletpoint Calculating Deemed Payments
Contracts
Get your contract reviewed right at the start and make sure it passes the IR35 status tests
Clients
Try to make sure your clients are on-side about IR35 from the beginning
Don’t take chances
Be realistic about your prospects of avoiding IR35 and don’t assume the taxman will never find out
But don’t cave in!
On the other hand, don’t cave in to IR35 too easily as your chances of avoiding it may be better than you think
Travel & sub
Make sure you don’t fall foul of the temporary workplace rules on travel and subsistence

Example

Tony works through his own service company as an IT consultant and his current contract is with a large bank. He charges fees of £60,000 a year for his services and has overheads of £2,000. The company receives bank interest of £3,000 per annum. He takes an annual salary of £5,720 and declares all remaining profits as dividend after setting aside funds for corporation tax. He also claims interest of £755 from the company to use up the balance of his personal allowance. His tax position for 2009/10 is as follows:-

Corporation tax - £11,450
Income tax - £2,354
National Insurance – Nil
Total tax and NI = £13,804

If he was caught by IR35, his Deemed Payment would be £45,461 and he would pay tax and NI as follows:

Corporation tax - £681
Income tax - £11,345
Employee NI - £4,271
Employer NI - £5,819
Total tax and NI = £22,116

Tony would have to pay an additional £8,312 under IR35. Most of this is due to the employer NI. In reality, he would probably have negotiated an increase in his fees to compensate for the fact that he was potentially liable for employer NI rather than the bank.

The fees in this example are deliberately set fairly low as it is assumed that all profits are taken as dividend. At higher levels of income this would greatly reduce the advantage of being outside IR35 as higher rate tax on the dividends tends to offset the benefit of not paying NI. There is very much a law of diminishing returns with dividends as the combined tax rate on them above the basic rate threshold is 46%.

If Tony shared the dividends with his wife (assuming she is not a higher rate tax payer) or kept retained profits within the company, his savings outside IR35 would be much higher as he could reduce or even totally avoid income tax on the dividends. However, he would not have access to retained profits within the company unless he either took them as dividends later or dissolved the company and took them as a capital distribution. This highlights the benefit of using the company as a tax shelter, as he could delay dividends until he was between contracts when his taxable income was much lower or pay just 10% tax on a capital distribution by claiming entrepreneurs relief.

Give us a call if you would like to discuss your contract or take advantage of our fixed rate deal.

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